Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors

Question

What will be an ideal response?

Answer 1

Answer: Preferred stockholders are paid before common stockholders in the event of bankruptcy. Common stockholders, as the residual owners of a corporation, would receive any monies remaining after bondholder and preferred stock claims are satisfied. Preferred dividends are paid before common stock dividends in the normal course of business. In the event that a preferred dividend is not paid, it accumulates and dividends in arrears must be paid before any common stock dividends can be declared. Common shareholders take the risk that they will not receive dividends. The magnitude of the cash flows from preferred is also known where it is not known for common stock. Because cash flows are more certain, preferred stock would be considered less risky to the investor.